PAY IT ON THE NET.

The online payment world finally has its long-awaited killer application - one that could radically change the face of person-to-person, person-to-business and business-to-business payments, and strike fear into the hearts of retail and commercial bankers around the world

Before the advent of e-commerce, the payments business was very predictable. A traditional business could accept payment from a person or another business using any combination of cash, cheques, credit cards, debit cards, electronic funds transfers (recurring or one-off) and/or wire transfers (using varying standards depending on the location of the businesses). Payment data was, and still is in many traditional businesses, transmitted over phone lines wire or dedicated data lines, or sometimes physically delivered to banks on magnetic tapes depending on volume and type of payment. Occasionally a new technology would be tried, like smart cards for example, but it was nearly impossible to supplant the standards that were closed to new entrants (i.e. Interac) or dominated by a few big players (i.e. MasterCard and Visa).

With the rise of the Internet in the 1990s came the need for secure, efficient online payment solutions for e-commerce transactions. Without a doubt, the credit card has been the leading payment method for consumers transacting online. In effect, a ubiquitous off-line payment technology was altered for the needs of online users. This makes sense when you consider that most consumers have a credit card, are very comfortable using it, and the credit card network is highly developed. Debit cards and electronic cheques, which access an individual's bank account directly to make payment, have always been a very distant second to credit cards. The fragmentation in the U.S. banking system has hindered the build-out of a national, real-time processing system for debit card transactions. It took MasterCard and Visa, with their national networks, to drive the growth of debit cards in the U.S. In Canada, even with our tight banking oligopoly and powerful Interac system, our banks have been slow and conservative in prov iding innovative online payment solutions.

But what about payments between businesses using the Internet? Nothing much has changed from the old days. Some banks have provided Web interfaces for business clients to process payments such as wires. Business-to-business (B2B) Internet-based supply-chain management solutions are still in the early stages and have to sort out numerous functional and integration issues before dealing with online payments. Business-to-business payment solutions over the Internet are no further ahead than consumer-to-business payment solutions.

The emergence of direct payments

Probably the single largest driver of change in the payment world has been the rise of eBay--the most famous flea market the world has ever known--and the need for online micropayment solutions between persons and small businesses. Micropayments are so small that transaction costs from payment solutions quickly wipe out any profit margins. Furthermore, it can be very difficult for individuals and businesses to obtain merchant accounts to accept credit card or other types of electronic payments. As eBay became more and more popular, numerous companies tried and failed to find a solution to the problem of making small payments from persons to other persons or small businesses.

In late 1998, a company finally solved the micropayment problem and in the process is challenging conventional retail and business payment solutions. PayPal, a Palo Alto, Calif.-based company, was originally formed by two people looking for a way to beam money to each other using Palm Pilots. Realizing that not enough people were using Palm Pilots, the founders developed an elegant payment solution using that ultra-popular communication channel--e-mail. The PayPal service allows a person or business to use e-mail to send and receive payments from any person or business with an e-mail address in 26 countries around the world. What's more, the company does not charge any fees for person-to-person transfers, subject to certain limitations. There is, however, one caveat: Outside of the U.S., the fee structure and functionality is not as attractive, although that is expected to change as competitors begin to enter the various markets. All transactions are secure and insured. If number of users is a primary measur e of success, then PayPal is a smashing success. The company now reports over six million users on its system and its solution can be considered a true killer app.

PayPal's solution is very simple, which is part of its attractiveness. A person or business sets up an account with PayPal that is used to send and receive payments to or from any other person or business with an e-mail address in any of 26 countries. Funds are transferred to a PayPal account from a bank account, debit card, credit card or even a cheque. If funds are sent from a PayPal account to a person or business without a PayPal account, that person or business receives an e-mail indicating that funds are available for receipt. Similar to Western Union, if you find out that you have funds waiting, you have a strong motivation to get to the local Western Union office, or in this case sign up for a PayPal account, to receive funds. Once funds are received, they can be transferred to a bank account, credit card or received by cheque for deposit.

Once the person-to-person payment service caught on, PayPal quickly expanded its solution by providing an auction payment service for users of eBay and premier and business accounts for active individual users and businesses. The company's Web site claims that it is the "#1 payment service on eBay. Trusted on over two million auctions." Payments can also be made with Internet-enabled mobile phones. Personal digital assistants should be added soon. The fees for U.S. users beat any payment solution on the market. As indicated earlier, fees are higher in other countries, including Canada, and some functionality is lacking.

PayPal can streamline our everyday payment needs in countless ways. For example, if you write a cheque to your landlord each month, he or she could accept an electronic payment and you could pay directly from your bank account or with a credit card using PayPal. If you and some friends are out for dinner one night and you're short on the bill, you can easily transfer funds to them through PayPal. It could even be done on the spot if you had an Internet-enabled mobile phone.

Consider the following example: A company wants to sell products or services online and needs a payment solution. Traditionally, the company would go through along, painful process of trying to obtain a merchant account, where it is at the mercy of the merchant account provider and could be rejected. If the company is in Canada, the process is even more suspect as U.S. merchant account providers don't like giving merchant accounts to Canadians and Canadian providers are expensive and slow to approve new applicants. If the company is accepted, it will be able to accept certain credit cards and maybe debit cards or electronic cheques. It is unlikely that the company could accept the gamut of payment alternatives. The alternative is to sign up with PayPal for a business account that allows a company to accept payments within a few days seamlessly through PayPal. As discussed, funds can be transferred into PayPal from a number of sources including credit card, debit card, bank account and cheque. Individuals who need to accept payments have no choice. They have to sign up with PayPal or a competing direct payment provider.

The threat to financial intermediaries

The biggest opportunity for PayPal and the biggest threat to traditional banks from online competition has still not been realized. At present, PayPal offers no incentive for users to retain funds at the company unless they are going to make payments to other PayPal users. Once funds are received in PayPal, a user must transfer the funds to a bank account to enjoy the full spectrum of banking services that the user needs. As soon as PayPal begins to offer traditional banking services to persons and businesses, such as interest on funds held, paper cheques and bill payments, the financial services landscape will be forever altered. The new payment standard that has reached critical user mass could begin offering standard online banking services as good as anyone else's very quickly. This scenario is coming closer to reality. The company currently offers a daily sweep feature (the ability to automatically move funds from a PayPal account to a bank account, or wherever, at a set time each day with no human inter vention), mass payments, and it recently announced an alliance with MasterCard to launch a co-branded debit card.

If imitation is the highest form of flattery, or maybe paranoia in this case, PayPal should feel flattered -- and paranoid. Banks, portals and other financial services companies are beginning to recognize the power of PayPal and are announcing competing services. In Canada, CIBC, Scotiabank and TD Canada Trust recently announced agreements with CertaPay to provide PayPal-like services to Canadian customers. CertaPay services will be similar to PayPal but will operate within the existing account structure of the banks that offer its services. There will be no need for users to open a new account with a new intermediary to send and receive person-to-person payments. In Canada, if financial institutions offer a fee structure similar to PayPal in the United States, they stand a strong chance of dominating the direct payments business.

There is no indication whether CertaPay will offer direct payment services to businesses. One major attraction of PayPal for businesses is the ability to receive online payments by credit card without a merchant account. For PayPal, it's all part of becoming a standard. The more places that a user can pay with PayPal, the less reason for a user to send funds any other way. Canadian companies, especially those selling to the U.S., would be wise to investigate PayPal's payment solutions. Analysts thought that online banking would revolutionize the financial services industry. With a killer banking app not available off-line -- they may finally be right.

Brice Scheschuk is president of Toronto-based Brave Consulting Corporation, a technology investment company. He is a frequent columnist on technology for Maclean's magazine. Brice can be reached at [e-mail].